Budgets: Not Exciting But So Important
February 17, 2022
Budgets...exciting? Not particularly, but extremely important for any small business or SME. Budgets are additional tools needed for goal setting and performance analysis. Detailed objectives are necessary for any business to operate profitably and grow into a long-term successful venture. When management does not know, however, whether the business has met predetermined objectives, operations become a “hit or miss” process from one accounting period to the next whether that is for a month, a quarter, semi-annually, or annually.
What is the Target?
A budget establishes future goals and objectives for a business. It is a target of where the business wants to go and, certainly, the company’s intention to hit the target. The budget should set the minimum standards for what the business wants to achieve even though it would like to see even better performance than predetermined goals.
Without having various goals and objectives and without comparing actual performance to budgeted targets, a business has no idea whether it is “on or off” target. Without this type of beneficial information, various operational and policy changes cannot be made with any degree of precision.
What is the Timeframe?
Although a budget can encompass any accounting period, for most small businesses and SMEs it will not extend beyond the current fiscal year considered to be short-term. Depending on the size and complexity of a small business or SME, a budget might extend into the next fiscal year or two. When preparing a budget and deciding what period or periods should be involved, an important reminder is that a budget is a working document so the business has a direction and goals. Therefore, the budget and its timeframe must be useful to management for it to be relevant. If not useful as a management tool, then a budget will serve no real beneficial purpose.
Who is Involved?
Depending on the size of the business and type of organizational structure, different individuals might be involved ranging from an owner or CEO to corporate officers, divisional managers, directors, department heads, or even key employees. For a budget (goals) to be on target and as realistic as possible, there must be open communication and “buy-in” among all participants. This makes for a more positive budget experience and creates a solid management tool.
Although a budget process takes time and effort, when everyone involved works together and communicates with honest intentions, business improves. Since some areas of a budget have an impact on other areas in a business, cross-communication is especially important. As examples, sales might have an impact on future capital expenditures, potential new hires will have an impact on payroll costs and benefits, or manufacturing goals will have an impact on labor and material costs.
How to get Started?
Reviewing past performance can be starting point. Although past performance is not necessarily an indicator of future performance, it can be a starting benchmark. These figures can then be considered as future expectations are planned based on expected operations, marketing campaigns, competition, the economy, and other internal and external variables that will affect future performance of the business.
What is the Best Budget?
There is not one budget that is best for all businesses. Some are easier to develop than others and some are easier for the reader to understand. The best budget is the one that an owner or management uses consistently as a roadmap to the future.
One business might use a simple format in which there are projected summary numbers for major categories while other businesses might have very detailed budgets by department, division, or location all rolled into what is considered to be a master budget or operations budget. There might also be individual budgets for sales, specialized expenses, or capital expenditures.
In addition to the aforementioned budgets, a budget might be prepared as a fixed or static budget that does not change during the budget period or a rolling budget that splits an annual budget into four quarterly periods. A rolling budget is so named because as soon as one quarter ends, the budget “rolls” in another quarter. This gives a business at least four future budgets (goals) to achieve; therefore, it forces management to constantly review performance and update goals. This type of constant evaluation keeps everyone more involved since the budget participants must keep current on factors that influence future business decisions.
Some businesses might even prepare what is referred to as a variable or “what if” budget. This would detail expected performance but would also include best case and worse case scenarios allowing the business flexibility for certain options such as reducing expenses in advance if revenue shows to be less than expected or increasing expenses in certain areas or purchasing additional equipment if revenue starts to exceed expectations.
Planning in Advance
Planning in advance is a key to operating an efficient and profitable small business or SME. Budgeting is an important aspect in the planning process.